Too Much Spending, Not Enough Savings: Destruction of an Economy
For every U.S. household that SAVED part of its income last year (you know who you are), there was another that spent more than it took in (and YOU know who YOU are, as well). On the surface, it may seem like there’s nothing wrong with households spending the whole wad. After all, it’s OK if income and expenses are in balance, right? Wrong.
The problem with households not saving is that over the long run, it ruins the economy.
Lack of savings means there are not enough long-term private bank reserves. Broadly, it translates into lack of investment in new business capital. Over time, that runs down the capital base of the economy. And improving business capital is, of course, the key to increasing productivity within an economy.
If productivity doesn’t increase, wages and living standards will stagnate – at best. Eventually, living standards decline. Don’t believe me? Have you been to Detroit lately?
Last year’s lack of savings was not a short-term phenomenon. The savings deficit was part of a long-term cultural phenomenon. The low savings rate in 2008 was one more data point in a string of many bad years for savings.
The personal savings rate in the U.S. makes for an interesting chart (see below, for 1930 to the present). The first thing that pops out is that savings were very high (near 25%) during World War II, when there were few consumer goods available to purchase.
All that wartime saving had much to do with kick-starting the U.S. economic explosion after the war ended. While the war was raging, many economists expected a postwar crash. That’s what had happened all the way back to the days of Napoleon.
In fact, the prospect of postwar mass unemployment, involving millions of demobilized soldiers, was one of the key drivers behind creating the G.I. Bill of Rights. It was better to send former soldiers off to college for a few years than to have them sitting around with no jobs, muttering into their beer mugs.
Instead of a postwar crash, however, the large pool of U.S. aggregate savings aligned with pent-up demand to spark a historic economic revival. In the 1950s and into the 1960s, the World War II generation settled down to raise its baby boom offspring. While savings rates cooled down, they still averaged a very respectable 8.5%. And this was in an era of very low inflation.
The national savings rate actually increased toward 10% during the 1970s and early 1980s. But from the mid-1980s onward, the national savings rate declined steadily. The rate was in the low single digits – and falling – by the early 2000s, and went negative in 2006 and 2007. For the U.S., these recent numbers were the lowest savings rate since the Great Depression.
What Was Going On?
Let’s review some large-scale trends that occurred during the past four decades. Starting in the 1970s, many women entered the U.S. labor force. More accurately, women exited the unpaid world of homemaking and entered the paid labor force.
The demographic shift of women into the labor force started as a trickle, but turned into a flood. Indeed, over the past 30 years, many traditionally male-dominated occupations and professions opened wide for women to pursue careers. Enrollments in U.S. law and medical schools, for example, are now well over 50% women. Just this year, over 50% of undergraduates majoring in earth sciences in the U.S. are women.
More women in the work force led to a fast-growing number of two-income households. But as pointed out by Elizabeth Warren, a professor and bankruptcy specialist at Harvard Law School, those extra paychecks often went to consumption, rather than savings.
For example, working couples took the second paycheck and bought a second car, if not a second house or condo. Working couples took more high-end vacations, as you can observe by driving past the cruise ship terminals at most major U.S. port cities. And the average size of new homes has increased during the past 25 years, even as average family size declined from over three to about 2.1 children per couple.
In short, Americans saved less over the past 35 years. But U.S. consumer spending took off and grew faster than the broad economy. Consumption accounted for 62% of gross domestic product (GDP) in the 1960s. But consumption grew to 70% of GDP between 2000-2007.
Looking at the numbers another way, “investment” in the economy plummeted from 38% of GDP to 30% – a drop of over 21% from the 1960s baseline. So it makes sense that much of the increase in consumption in recent years was of imported goods. Thus did high consumption and low savings help to decapitalize the nation, as trillions of dollars wound up in foreign accounts.
And Then What Happened?
With high consumption and low savings, when the current recession hit, it hit hard. In fact, the effects of the recession were aggravated by the national pattern of high consumption and low savings over the past decades.
Let’s begin with the fact that many households spent every dollar that came in. Then they borrowed against the so-called “equity” in their house (often as not, the equity was mostly a product of inflation) to finance further consumption. But there’s a funny thing about borrowing money. Usually, the lender wants it paid back.
As Harvard’s professor Warren has pointed out, many two-income households painted themselves into a “two-income trap.” That is, when both wage-earners devote their entire paycheck to consumption, with nothing going into savings, the loss of one job can be a financial catastrophe. A household at the margin almost instantly goes underwater.
Also, it’s becoming clear that in the past year, many job losses in the U.S. economy are permanent. Instead of temporary layoffs, many jobs are being eliminated as part of a structural retrenchment of the U.S. economy. Think about the job losses in the auto and auto parts industries, in banking and finance, or in real estate. Many of these jobs are just plain history. These industries will never recover to the glory days of old.
Along these lines, a recent survey conducted by The Wall Street Journal reveals that 52% of companies polled expect to employ fewer people over the next five years. That can hardly be reassuring to the rapidly expanding ranks of the unemployed in large states like California, Michigan, Illinois and others. Big states with large numbers of jobless people make for big, long-term, intractable social and political issues.
The “Recovery-Less Recovery”
So the job cuts, and long-term unemployment, are here to stay. Much of this has to do with the previous lack of savings and long-term investment. After two decades of falling savings, and related underinvestment in new business capital, there is not enough momentum within the job-creation engine of the U.S. economy. The machine is stalled.
It’s not like you can accelerate the process of job creation, either. Sure, government can spend a lot of money (borrowed money, as it turns out) in a hurry on so-called “stimulus” programs. But what will that accomplish? People still can’t find long-term employment – let alone careers and employment security – in industries that don’t exist or never took root. Nobody gets hired in a firm or factory that never got built. So now we’re experiencing what many economists are calling a “jobless recovery.”
Jobless recovery? That might be whistling past the graveyard. Indeed, the lack of job creation going forward could also lead to a “recovery-less recovery.” Or to paraphrase former President Richard Nixon, speaking of the idea of Keynesian economics, we’re all living in the Rust Belt now.
Some Households Are Saving Again
There is some good news from the savings front, however. As 2009 unfolds, it appears that debt-burdened American households are desperately beginning to save. In April 2009, the national savings rate jumped to 5.7%, the highest level in 14 years.
Still, savings has to come out of something else. Households “saved,” but the other side of the coin is that “consumers” ratcheted down their spending – and did so even faster than aggregate incomes fell. That means empty shopping malls and auto lots. It’s a vicious cycle.
“Americans have learned a cruel, cold, hard lesson,” according to Bernard Baumohl, an economist for the Economic Outlook Group of Princeton, N.J. “People are scared. And that’s led them to replenish their savings because they now realize that their retirement nest eggs will no longer increase on automatic pilot.”
There’s no disputing the extraordinary shock to household wealth in the U.S. From mid-2007-March 2009, according to the Federal Reserve, household net worth plunged $14 trillion, or 21.5%. Just during the second half of 2008, household net worth plummeted nearly $8 trillion – with an eye-popping $4.9 trillion dip in the fourth quarter.
Meanwhile, the broad-based Standard & Poor’s 500-stock index shed 57% of value between October 2007-March 2009. While the S&P 500 has increased 36% since its March low, it is still 41% below its 2007 peak.
According to Mr. Baumohl, the economist, “There has been a fundamental shift in the behavior of American households.” That is, savings are now a priority of financial planning. Mr. Baumohl believes that we’ll continue to see the savings rate increase to between 7-9%, where it will likely hold steady for at least several years. Many of the 75 million baby boomers are now revising their retirement plans, figuring out how to work longer, save more and spend less. (Meanwhile, the federal government is working to figure out how to pay lower Social Security and Medicare benefits to those baby boomers.)
All in all, we should expect to see U.S. consumer spending grow more slowly than GDP over the next decade. As a percent of GDP, investment will increase as some fortunate households replenish savings. But any recovery will be slower than most observers expect – particularly the politicians, who cannot abide large numbers of unemployed people near Election Day.
Rooting for the Savers
The good news is that over the long-term, more savings will translate into more business investment. That should create new jobs and raise productivity, which are the basic building blocks for a rising standard of living.
Of course, there are problems with any significant shift in the direction of capital flow in the U.S. economy. But despite any issues, the unemployed of the U.S. need to root for the savers. And the politicians, of course, need to respect the process of saving. Because without those savings, the economy will continue to wind down.
And what if the political rhetoric descends into class warfare? What if the savers of the nation become objects of ridicule, subject to punitive levels of taxation and regulation? In that case, we get back to the idea that capital is portable.
If savings cannot find a safe harbor in the U.S., then the capital flows will keep moving offshore. And if that happens, all bets are off for the U.S. economy. We can just sit back and listen as the band plays “Nearer, My God, to Thee.”
Until we meet again,
July 2, 2009